Definition

• The IRS divides income into two broad categories; nontaxable and taxable income. The larger of the categories is, of course, taxable income and its rate of tax depends on the source of income. Dividends are not taxed at the same rate as wages and wages aren't taxed at the same rate as Social Security retirement benefits. Nontaxable income, however, is 100 percent exempt from federal income tax.
  
  

Examples

• Veterans' disabilities are those distributed by the Department of Veterans affairs and they are considered exempt from tax. However, there are other categories of disability payments which are also not required to be included in your gross income. For example, Supplemental Security Income is a benefit paid to elderly people and disabled people. Although it is distributed by the Social Security administration, the money for the payments comes directly from the general fund for the Treasury and is not required to be included on your return as income.
  
  

Considerations

• The only disability income types deemed nontaxable are those explicitly categorized as nontaxable by the IRS. Not all categories of disability pensions meet this requirement. For example, Social Security disability payments are taxed at the same rate as Social Security retirement benefits. Recipients of Social Security disability who are individual filers and have a combined income of between $25,000 and $34,000 are subject to a 50 percent tax on their Social Security benefits. Individual filers who earn in excess of $34,000 are subject to a tax of up to 85 percent of their income. Joint filers who earn between $32, 000 and $44,000 may pay tax on up to 50 percent of their benefits while those who earn more than $44,000 are subject to 85 percent tax on their benefits. Most filers won't reach these income thresholds unless they earn income in addition to their monthly disability benefit amount.
  
  

Warning

• Although having a significant amount of your income come from nontaxable disability often means that you are not required to file a return, it doesn't mean that you wouldn't benefit from filing. Recipients of disability benefits who earn income in addition to their disability payments may be eligible for the earned income credit or the making work pay credit. Both these credits are refundable and could result in significant refunds.